LLC “Lien Priority” Battle: Billing Order vs. UCC Funding Statement | Patton Sullivan Brodehl LLP

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A load order is a device used by a judgment creditor to collect a judgment against an LLC member. The arraignment order imposes a lien on the judgment debtor’s economic (or “transferable”) interest in the LLC – the order essentially diverts LLC distributions from the judgment debtor to the judgment creditor until the debt is satisfied. If the debt remains unsatisfied (for example, due to no or insufficient distributions), the creditor can optionally “exclude” the charging order and obtain permanent ownership of the member’s economic interest.

A UCC Funding Status is a different tool commonly used by a general creditor to secure the debt of an LLC or an LLC member. In a typical arrangement, the LLC member will pledge their interest in the LLC as security for the debt, and this pledge will be documented on a UCC financing statement, which is filed with the Secretary of State. Like a billing order, a UCC funding statement functions as a lien on the LLC member’s right to distributions.

A case recently released by California’s Second Appellate District – Rice against Downs —dealed with the competing “priority” of creditors’ liens over a debtor’s interest in the LLC, where one creditor had a postjudgment charging order and the other creditor had a UCC financing statement. The court also explained that even payments that are not called “distributions” could, in fact, be distributions subject to the scope of a billing order.

Charge Order Privilege

Gary Downs has sued and won judgment against William Rice for “hundreds of thousands of dollars” in a case stemming from disputes within a company developing affordable housing.

After the judgment, the trial court granted Downs’ motion for a charging order directing various limited liability companies of which Rice was a member to pay all distributions to which Rice was entitled directly to Downs until the judgment is satisfied.

The “payment” (distribution?) of the LLC to a third party

Downs eventually learned that one of Rice’s LLCs (Triton Community Development LLC) had paid $450,000 to Glasser Weil – a law firm representing Rice in her litigation against Downs.

Downs filed a motion in the trial court to enforce his charging order, arguing that Triton’s $450,000 payment to Glasser Weil violated the order. Downs argued that the payment was really a distribution subject to the billing order and that Rice should either pay this sum to Downs or Glasser Weil should return the funds to Downs.

The UCC Funding Statement Privilege

Glasser Weil opposed Downs’ motion, making two points:

First, he claimed that months before the $450,000 payment, Triton had agreed to become co-debtor of Rice’s debt to the law firm. Thus, according to Glasser Weil, the payment was not a distribution that would be subject to the billing order, but rather an independent payment on Triton’s debt.

Second, he claimed he had “perfect security” in the form of a UCC financing statement which was filed with the Secretary of State on the same date that Triton agreed to become co-debtor on the debt of Rice to the company – months prior, and thus “senior to” Downs’ charge order privilege.

Trial Court: Equity trumps privilege UCC

The trial court granted Downs’ motion to enforce the charging order, relying on his “fair exercise of jurisdiction.”

The court held that it would be unfair to let the money pass through the hands of it the way it did – “for the Glasser company to say to Mr. Rice, ‘Deliver sand.’ I have the money now. We have perfected our privilege. We have to find something else. »

Court of Appeal: reversed; the payment was a “distribution” subject to the billing order, but the UCC lien took precedence

The Court of Appeal overturned the trial court’s order.

The LLC’s payment was a “distribution” subject to the billing order…

Addressing Glasser Weil’s two arguments, the court rejected the first, finding that Triton’s $450,000 payment was, in fact, “a distribution subject to the imputation order”.

The court found that Glasser Weil’s “narrow reading” of the scope of the charging order “disregards the fact that many limited liability companies, such as Triton, are wholly controlled by a single person who can distribute funds at its discretion. … Under Glasser Weil’s interpretation, these entities could easily evade billing orders by avoiding formal distributions and instead withdrawing funds from the LLC when needed.

The court added: “Even though Triton made the payment pursuant to its own contractual obligation to Glasser Weil, the fact remains that the payment was for Rice’s legal fees. … The payment therefore constituted a “distribution” insofar as Rice had himself received the money.

As an additional independent ground in support of its reasoning, the court also noted that the evidence supported the conclusion that “Triton was Rice’s alter ego”, and that the court could therefore “override the formalities of the business and view the transaction as Rice handing out money to himself”. of Triton to pay his legal fees. … Triton and Rice were effectively one and the same.

… but the privilege of the UCC’s financing statement took precedence over the charging order.

The court was more receptive to Glasser Weil’s second argument based on the priority of his lien on the UCC funding statement. The court held that the UCC Funding Statement lien took precedence over the Downs Billing Order lien, and “there was no equitable basis for the trial court to set aside that priority” .

In resolving the priority of lien issue, the court followed the “first in” rule – the starting point for “priority of lien” analysis in a wide variety of California cases. Under this rule, “all other things being equal, different liens on the same property take precedence depending on when they were created.”

Glasser Weil honed his lien by filing his UCC financing statement in July 2019. Downey obtained his arraignment lien several months later, in October 2019. The court found, “The prior perfected security right of Glasser Weil therefore has priority.

Course

Under Rice against Downs, the priority of competing liens over an LLC interest (here, a charge order versus a UCC funding state) will be determined by the “first come” rule. Further, billing orders cannot be evaded simply by requalifying what is functionally a distribution as another type of payment.

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